Yahoo's stock is getting hit after an unfavorable ruling on its Alibaba spinoff

Yahoo CEO Marissa Mayer. Reuters/Ruben Sprich Yahoo's stock is sliding after an unfavorable ruling on its planned tax-free Alibaba spinoff. Yahoo shares are down about 4% in after-hours trading.

Yahoo owns 384 million shares of Chinese e-commerce giant Alibaba, which it plans to spin off into a separate company (along with Yahoo's own small-business unit) in a tax-free transaction that will ultimately return much of the value to Yahoo shareholders.

In other words, the IRS is not telling Yahoo it can rest easy about the deal getting approved.

"On September 2, 2015, the IRS notified Yahoo's counsel that it had determined, in the exercise of its discretion, not to grant the requested ruling. At the same time, the IRS indicated that it had not concluded that the proposed spin-off transaction was taxable and therefore was not ruling adversely on the request," Yahoo said in a filing with the SEC on Tuesday.

Yahoo has previously said it expected the spinoff to be completed by the end of the year. Yahoo noted in Tuesday's filing that its lawyers continue to believe the proposed spin off will satisfy the IRS requirements.

"Work proceeds on the pending Aabaco spin-off plan. Yahoo's Board of Directors will continue to carefully consider the Company's options, including proceeding with the spin-off transaction on the basis of an opinion of counsel," Yahoo said.

Yahoo investors have long clamored for Yahoo to cash out its investment in Alibaba (and in Yahoo Japan) and give the proceeds back to shareholders. It's crucial for Yahoo shareholders that the Alibaba spin-off get tax-free treatment. Otherwise shareholders might lose up to a third of the payoff from Yahoo's monetization of its Alibaba stake in tax payments.

On February 26, 2015, Yahoo submitted to the IRS a request for a private letter ruling with respect to whether Aabaco's ownership and operation of ASB would satisfy the active trade or business requirement (the "ATB Requirement") under Section 355 of the Internal Revenue Code of 1986, as amended (the "Code"). On May 19, 2015, the IRS announced that it was reconsidering its ruling policy with respect to the ATB Requirement. On July 31, 2015, the IRS formally announced that it was studying potential new administrative guidance with respect to certain issues under Section 355 of the Code, including the ATB Requirement. On September 2, 2015, the IRS notified Yahoo's counsel that it had determined, in the exercise of its discretion, not to grant the requested ruling. At the same time, the IRS indicated that it had not concluded that the proposed spin-off transaction was taxable and therefore was not ruling adversely on the request. Following receipt of such notification, Yahoo withdrew its request for a ruling on September 2, 2015.

Subsequent to the IRS's decision with respect to its ruling request, Yahoo confirmed with its tax counsel, Skadden, Arps, Slate, Meagher & Flom LLP ("Skadden"), that the discretionary decision by the IRS not to grant Yahoo's ruling request with respect to the ATB Requirement did not reflect any change in U.S. tax law with respect to the tax-free treatment of the proposed spin-off and would not affect Skadden's ability to render an opinion that, under current law and subject to certain factual representations and assumptions, the currently proposed spin-off will satisfy all of the requirements for tax-free treatment under the Code, including the ATB Requirement.

Work proceeds on the pending Aabaco spin-off plan. Yahoo's Board of Directors will continue to carefully consider the Company's options, including proceeding with the spin-off transaction on the basis of an opinion of counsel.